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Learning Objectives

Power Notes. Chapter 6. Financial Statement Analysis. Users of Financial Statement Importance of Financial Statement Analysis Basic Analytical Procedures Solvency Analysis Profitability Analysis Efficiency Analysis Summary of Analytical Measures. Learning Objectives. C6.

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Learning Objectives

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  1. Power Notes Chapter 6 Financial Statement Analysis • Users of Financial Statement • Importance of Financial Statement Analysis • Basic Analytical Procedures • Solvency Analysis • Profitability Analysis • Efficiency Analysis • Summary of Analytical Measures Learning Objectives C6

  2. USERS OF FINANCIAL STATEMENT Employees and Managers Stockholders and Creditors Internal Stakeholders Government Taxation Business Entity Regulatory Bodies Suppliers and Customers

  3. DIFFERENT USERS NEED OF INFORMATION MANAGER Planning and organizing business Banks To approve loan application vendors Determine credit term and credit limit Shareholders Predict investment return & Future risk

  4. IMPORTANCE OF FINANCIAL STATEMENT ANALYSIS Analysis helps user to….. • generate more meaningful information • for making decision. • analyse relationship between financial • statement components and the trend. • measure company’s performance & to predict • potential risk in the future

  5. BASIS OF COMPARISONS • Intra company • to compare one company’s performance for several years (3 to 5 years) • Inter company (competitor) • Compare company’s performance with other company (similar industries) • Industrial average • to compare company’s performance with industrial average performance (average performance of the companies in similar industries)

  6. BASIC ANALYTICAL PROCEDURES PERCENTAGE ANALYSIS HORIZONTAL VERTICAL COMMON-SIZE

  7. PERCENTAGE ANALYSIS

  8. HORIZONTAL ANALYSIS Analysing performance change by percentage in related items in comparative financial statements.

  9. Mercu Tanda Sdn Bhd Comparative Balance SheetDecember 31, 2003 and 2002 Increase (Decrease) 2003 2002 Amount Percent Assets Current assets RM 550,000 RM 533,000 RM 17,000 3.2% Long-term investments 95,000 177,500 (82,500) (46.5%) Fixed assets (net) 444,500 470,000 (25,500) (5.4%) Intangible assets 50,000 50,000 — RM1,139,500 RM1,230,500 RM (91,000) (7.4%) Liabilities Current liabilities RM 210,000 RM 243,000 RM (33,000) (13.6%) Long-term liabilities 100,000 200,000 (100,000) (50.0%) RM 310,000 RM 443,000 RM(133,000) (30.0%) Stockholders’ Equity Preferred 6% stock,RM100 RM150,000 RM 150,000 — Common stock, RM10 par 500,000 500,000 — Retained earnings 179,500 137,500 RM42,000 30.5% Total stockholders’ equity RM829,500 RM 787,500 RM42,000 5.3% Total liabilities and Stockholders’ equity RM1,139,500 RM1,230,500 RM(91,000) (7.4%)

  10. Mercu Tanda Sdn Bhd Comparative Balance SheetDecember 31, 2003 and 2002 Increase (Decrease) 2003 2002 Amount Percent Assets Current assets RM 550,000 RM 533,000 RM 17,000 3.2% Long-term investments 95,000 177,500 (82,500) (46.5%) Fixed assets (net) 444,500 470,000 (25,500) (5.4%) Intangible assets 50,000 50,000 — RM1,139,500 RM1,230,500 RM (91,000) (7.4%) Liabilities Current liabilities RM 210,000 RM 243,000 RM (33,000) (13.6%) Long-term liabilities 100,000 200,000 (100,000) (50.0%) RM 310,000 RM 443,000 RM(133,000) (30.0%) Stockholders’ Equity Preferred stock,RM100 par RM150,000 RM 150,000 — Common stock, RM10 par 500,000 500,000 — Retained earnings 179,500 137,500 RM42,000 30.5% RM 829,500 RM 787,500 RM42,000 5.3% RM1,139,500 RM1230,500 RM(91,000) (7.4%) Horizontal Analysis: Current year (2003) RM550,000 Base year (2002) RM533,000 = 103.2% Increase amount RM17,000 Base year (2002) RM533,000 = 3.2%

  11. Mercu Tanda Sdn Bhd Comparative Income StatementFor the Years Ended December 31, 2003 and 2002 Increase (Decrease) 2003 2002 Amount Percent Sales RM1,530,500 RM1,234,000 RM296,500 24.0% Sales returns 32,500 34,000 (1,500) (4.4%) Net sales 1,498,000 1,200,000 298,000) 24.8% Cost of goods sold 1,043,000 820,000 223,000 27.2% Gross profit 455,000 380,000 75,000 19.7% Selling expenses 191,000 147,000 44,000 29.9% Administrative expenses 104,000 97,400 6,600 6.8% Total operating expenses 295,000 244,400 50,600 20.7% Operating income 160,000 135,600 24,400 18.0% Other income 8,500 11,000 (2,500) (22.7%) 168,500 146,600 21,900 14.9% Other expense 6,000 12,000 (6,000) (50.0%) Income before income tax 162,500 134,600 27,900 20.7% Income tax 71,500 58,100 13,400 23.1% Net income 91,000 76,500 14,500 19.0%

  12. Mercu Tanda Sdn Bhd Comparative Income StatementFor the Years EndedDecember 31, 2003 and 2002 Increase (Decrease) 2003 2002 Amount Percent Sales RM1,530,500 RM1,234,000 RM296,500 24.0% Sales returns 32,500 34,000 (1,500) (4.4%) Net sales 1,498,000 1,200,000 298,000) 24.8% Cost of goods sold 1,043,000 820,000 223,000 27.2% Gross profit 455,000 380,000 75,000 19.7% Selling expenses 191,000 147,000 44,000 29.9% Administrative expenses 104,000 97,400 6,600 6.8% Total operating expenses 295,000 244,400 50,600 20.7% Operating income 160,000 135,600 24,400 18.0% Other income 8,500 11,000 (2,500) (22.7%) 168,500 146,600 21,900 14.9% Other expense 6,000 12,000 (6,000) (50.0%) Income before income tax 162,500 134,600 27,900 20.7% Income tax 71,500 58,100 13,400 23.1% Net income 91,000 76,500 14,500 19.0% Horizontal Analysis: Current year (2003) RM1,498,000 Base year (2002) RM1,200,000 = 124.8% Increase amount RM298,000 Base year (2002) RM1,200,000 = 24.8%

  13. VERTICAL ANALYSIS Analysing performance change by percentage of each component to the total within a single statements

  14. Mercu Tanda Sdn Bhd Comparative Balance Sheet December 31, 2003 and 2002 2003 2002 Amount Percent Amount Percent Assets Current assets RM 550,000 48.3% RM 533,000 43.3% Long-term investments 95,000 8.3 177,500 14.4 Fixed assets (net) 444,500 39.0 470,000 38.2 Intangible assets 50,000 4.4 50,000 4.1 RM1,139,500 100.0% RM1,230,500 100.0% Liabilities Current liabilities RM 210,000 18.4% RM 243,000 19.7% Long-term liabilities 100,000 8.8 200,000 16.3 RM 310,000 27.2% RM 443,000 36.0% Stockholders’ Equity Preferred stock, RM100 par RM150,000 13.2% RM 150,000 12.2% Common stock, RM10 par 500,000 43.9 500,000 40.6 Retained earnings 179,500 15.7 137,500 11.2 RM 829,500 72.8% RM 787,500 64.0% RM1,139,500 100.0% RM1230,500 100.0%

  15. Mercu Tanda Sdn Bhd Comparative Balance Sheets December 31, 2003 and 2002 2003 2002 Amount Percent Amount Percent Assets Current assets RM 550,000 48.3% RM 533,000 43.3% Long-term investments 95,000 8.3 177,500 14.4 Fixed assets (net) 444,500 39.0 470,000 38.2 Intangible assets 50,000 4.4 50,000 4.1 RM1,139,500 100.0% RM1,230,500 100.0% Liabilities Current liabilities RM 210,000 18.4% RM 243,000 19.7% Long-term liabilities 100,000 8.8 200,000 16.3 RM310,000 27.2% RM 443,000 36.0% Stockholders’ Equity Preferred stock, RM100 parRM150,000 13.2% RM 150,000 12.2% Common stock, RM10 par 500,000 43.9 500,000 40.6 Retained earnings 179,500 15.7 137,500 11.2 RM829,500 72.8% RM787,500 64.0% RM1,139,500 100.0% RM1230,500 100.0% Vertical Analysis: Asset items 2003 Current assets RM550,000 Total assets RM1,139,500 = 48.26% 2002 Current assets RM533,000 Total assets RM1,230,500 = 43.32%

  16. Mercu Tanda Sdn Bhd Comparative Balance SheetsDecember 31, 2003 and 2002 2003 2002 Amount Percent Amount Percent Assets Current assets RM 550,000 48.3% RM 533,000 43.3% Long-term investments 95,000 8.3 177,500 14.4 Fixed assets (net) 444,500 39.0 470,000 38.2 Intangible assets 50,000 4.4 50,000 4.1 RM1,139,500 100.0% RM1,230,500 100.0% Liabilities Current liabilities RM 210,000 18.4% RM 243,000 19.7% Long-term liabilities 100,000 8.8 200,000 16.3 RM310,000 27.2% RM 443,000 36.0% Stockholders’ Equity Preferred stock, RM100 par RM 150,000 13.2% RM 150,000 12.2% Common stock, RM10 par 500,000 43.9 500,000 40.6 Retained earnings 179,500 15.7 137,500 11.2 RM829,500 72.8% RM787,500 64.0% RM1,139,500 100.0% RM1230,500 100.0% Vertical Analysis: liability items 2003 : Current liabilities RM210,000 Liability & equity RM1,139,500 = 18.4%

  17. Mercu Tanda Sdn Bhd Comparative Balance SheetsDecember 31, 2003 and 2002 2003 2002 Amount Percent Amount Percent Assets Current assets RM 550,000 48.3% RM 533,000 43.3% Long-term investments 95,000 8.3 177,500 14.4 Fixed assets (net) 444,500 39.0 470,000 38.2 Intangible assets 50,000 4.4 50,000 4.1 RM1,139,500 100.0% RM1,230,500 100.0% Liabilities Current liabilities RM 210,000 18.4% RM 243,000 19.7% Long-term liabilities 100,000 8.8 200,000 16.3 RM310,000 27.2% RM 443,000 36.0% Stockholders’ Equity Preferred stock, RM100 par RM 150,000 13.2% RM 150,000 12.2% Common stock, RM10 par 500,000 43.9 500,000 40.6 Retained earnings 179,500 15.7 137,500 11.2 RM829,500 72.8% RM787,500 64.0% RM1,139,500 100.0% RM1230,500 100.0% Vertical Analysis: liability items 2002 : Current liabilities RM243,000 Liability & equity RM1,230,500 = 19.75%

  18. Mercu Tanda Sdn Bhd Comparative Balance Sheets December 31, 2003 and 2002 2003 2002 Amount Percent Amount Percent Assets Current assets RM 550,000 48.3% RM 533,000 43.3% Long-term investments 95,000 8.3 177,500 14.4 Fixed assets (net) 444,500 39.0 470,000 38.2 Intangible assets 50,000 4.4 50,000 4.1 RM1,139,500 100.0% RM1,230,500 100.0% Liabilities Current liabilities RM 210,000 18.4% RM 243,000 19.7% Long-term liabilities 100,000 8.8 200,000 16.3 RM310,000 27.2% RM 443,000 36.0% Stockholders’ Equity Preferred stock, RM100 par RM 150,000 13.2% RM 150,000 12.2% Common stock, RM10 par 500,000 43.9 500,000 40.6 Retained earnings 179,500 15.7 137,500 11.2 RM829,500 72.8% RM787,500 64.0% RM1,139,500 100.0% RM1230,500 100.0% Vertical Analysis: Owner’s equity items 2003: Retained earning RM179,500 Liability & equity RM1,139,500 = 15.75% 2003: Retained earning RM137,500 Liability & equity RM1,230,500 = 11.17%

  19. Mercu Tanda Sdn Bhd Comparative Income StatementFor the Years Neded December 31, 2003 and 2002 Increase (Decrease) 2003 2002 Amount Percent Sales RM1,530,500 RM1,234,000 Sales returns 32,500 34,000 Net sales 1,498,000 1,200,000 Cost of goods sold 1,043,000 820,000 Gross profit 455,000 380,000 Selling expenses 191,000 147,000 Administrative expenses 104,000 97,400 Total operating expenses 295,000 244,400 Operating income 160,000 135,600 Other income 8,500 11,000 168,500 146,600 Other expense 6,000 12,000 Income before income tax 162,500 134,600 Income tax 71,500 58,100 Net income 91,000 76,500 vertical analysis: income statement items Net income (2003) RM 91,000 Net sales (2003) RM1,498,000 = 6.07% Net income (2002) RM 76,500 Net sales (2002) RM1,200,000 = 6.4%

  20. COMMON-SIZE STATEMENTS Useful to compare the current with prior periods, individual businesses, or one business with industry percentages. All items are normally expressed in percentages.

  21. Mercu Tanda Sdn Bhd Comparative Balance SheetsDecember 31, 2003 and 2002 2003 2002 Amount Percent Amount Percent Common-Size Statements Assets Current assets RM 550,000 48.3% RM 533,000 43.3% Long-term investments 95,000 8.3 177,500 14.4 Fixed assets (net) 444,500 39.0 470,000 38.2 Intangible assets 50,000 4.4 50,000 4.1 RM1,139,500 100.0% RM1,230,500 100.0% Liabilities Current liabilities RM 210,000 18.4% RM 243,000 19.7% Long-term liabilities 100,000 8.8 200,000 16.3 RM310,000 27.2% RM 443,000 36.0% Stockholders’ Equity Preferred stock, RM100 par RM150,000 13.2% RM 150,000 12.2% Common stock, RM10 par 500,000 43.9 500,000 40.6 Retained earnings 179,500 15.7 137,500 11.2 RM829,500 72.8% RM787,500 64.0% RM1,139,500 100.0% RM1230,500 100.0%

  22. BUILDING BLOCKS OF FINANCIAL STATEMENT ANALYSIS RATIO ANALYSIS SOLVENCY PROFITABILITY EFFICIENCY

  23. Ratio Analysis

  24. Solvency Analysis Solvency is the ability of a business to meet its financial obligations (debts) as they are due. Solvency analysis focuses on the ability of a business to pay or otherwise satisfy its currentandnoncurrent liabilities. This ability is normally assessed by examining balance sheetrelationships.

  25. Solvency Ratios Solvency (short term/ liquidity) • Working capital • Current ratio • Acid-test ratio Solvency (long-term) • Fixed assets to long term liabilities • Ratio of liabilities to shareholder’s equity • Times interest charges • Debt ratio • Equity ratio

  26. Solvency Measures — The Short-Term Creditor (liquidity) Working Capital and Current Ratio 2003 2002 Current assets RM550,000 RM533,000 Current liabilities 210,000 243,000

  27. Solvency Measures — The Short-Term Creditor Working Capital and Current Ratio 2003 2002 Current assets RM550,000 RM533,000 Current liabilities 210,000 243,000 Working capital RM340,000 RM290,000 Use: To indicate the ability to meet currently maturing obligations.

  28. Solvency Measures — The Short-Term Creditor Working Capital and Current Ratio 2003 2002 Current assets RM550,000 RM533,000 Current liabilities 210,000 243,000 Working capital RM340,000 RM290,000 Current ratio 2.6 2.2 Divide current assets by current liabilities Use: To indicate the ability to meet currently maturing obligations.

  29. Solvency Measures — The Short-Term Creditor Acid-Test Ratio 2003 2002 Quick assets: Cash RM 90,500 RM64,700 Marketable securities 75,000 60,000 Accounts receivable (net) 115,000 120,000 Total RM280,500 RM244,700 Current liabilities RM210,000 RM243,000

  30. Solvency Measures — The Short-Term Creditor Acid-Test Ratio 2003 2002 Quick assets: Cash RM 90,500 RM 64,700 Marketable securities 75,000 60,000 Accounts receivable (net) 115,000 120,000 Total RM280,500 RM244,700 Current liabilities RM210,000 RM243,000 Acid-test ratio 1.3 1.0 Use: To indicate instant debt-paying ability.

  31. Solvency Measures — The Long-Term Creditor Ratio of Fixed Assets to Long-Term Liabilities 2003 2002 Fixed assets (net) RM444,500 RM470,000 Long-term liabilities RM100,000 RM200,000

  32. Solvency Measures — The Long-Term Creditor Ratio of Fixed Assets to Long-Term Liabilities 2003 2002 Fixed assets (net) RM444,500 RM470,000 Long-term liabilities RM100,000 RM200,000 Ratio of fixed assets to long-term liabilities 4.4 2.4 Use: To indicate the margin of safety to long-term creditors.

  33. Solvency Measures — The Long-Term Creditor Ratio of Liabilities to Stockholders’ Equity 2003 2002 Total liabilities RM310,000 RM443,000 Total stockholders’ equity RM829,500 RM787,500

  34. Solvency Measures — The Long-Term Creditor Ratio of Liabilities to Stockholders’ Equity 2003 2002 Total liabilities RM310,000 RM443,000 Total stockholders’ equity RM829,500 RM787,500 Ratio of liabilities to stockholders’ equity 0.37 0.56 Use: To indicate the margin of safety to creditors.

  35. Solvency Measures — The Long-Term Creditor Number of Times Interest Charges Earned 2003 2002 Income before income tax RM 900,000 RM 800,000 Add interest expense 300,000 250,000 Amount available for interest 1,200,000 1,050,000

  36. Solvency Measures — The Long-Term Creditor Number of Times Interest Charges Earned 2003 2002 Income before income tax RM 900,000 RM 800,000 Add interest expense 300,000 250,000 Amount available for interest 1,200,000 1,050,000 Number of times earned 4.0 4.2 Use: To assess the risk to debtholders in terms of number of times interest charges were earned.

  37. Solvency Measures — The Long-Term Creditor Debt Ratio 2003 2002 Total liabilities RM 310,000 RM 443,000 Total assets RM1,139,500 RM1,230,500

  38. Solvency Measures — The Long-Term Creditor Debt Ratio 2003 2002 Total liabilities RM 310,000 RM 443,000 Total assets RM1,139,500 RM1,230,500 Debt Ratio 0.27 0.36 Use: To measure the extent of credit used to finance the assets.

  39. Solvency Measures — The Long-Term Creditor Equity Ratio 2003 2002 Stockholders’ equity RM 829,500 RM 787,500 Total assets RM1,139,500 RM1,230,500

  40. Solvency Measures — The Long-Term Creditor Equity Ratio 2003 2002 Stockholders’ equity RM 829,500 RM 787,500 Total assets RM1,139,500 RM1,230,500 Equity Ratio 0.73 0.64 Use: To measure the extent of owners’ equity used to finance the assets.

  41. Profitability Analysis Profitability is the ability of an entity to earn profits. This ability to earn profits depends on the effectiveness and efficiency of operationsas well as resources available. Profitability analysisfocuses primarily on the relationship between operating results reported in the income statementand resources reported in the balance sheet.

  42. Profitability Ratios • Profit margin • Gross profit margin • Rate earned on total assets (ROA) • Rate earned on stockholders’s equity (ROE) • Rate earned on common stockholder’s equity • Earning per share • Price earning ratio • Dividends per share • Dividend yield

  43. Profitability Measures — Operating Profit Margin 2003 2002 Net profit RM 91,000 RM 76,500 Net sales 1,498,000 1,200,000 Profit margin 0.06 0.06 Use: To assess the efficiency of the business in controlling all costs relating to sales.

  44. Profitability Measures — Operating Gross Profit Margin 2003 2002 Gross profit RM 455,000 RM 380,000 Net sales 1,498,000 1,200,000 Gross profit margin 0.3 0.32 Use: To assess the efficiency of the business in dealing with purchases and its related costs.

  45. Profitability Measures — The Common Stockholder Rate Earned on Total Assets 2003 2002 Net income RM 91,000 RM 76,500 Plus interest expense 6,000 12,000 Total 97,000 88,500 Total assets: Beginning of year 1,230,500 1,187,500 End of year 1,139,500 1,230,500 Total 2,370,000 2,418,000 Average 1,185,000 1,209,000

  46. Profitability Measures — The Common Stockholder Rate Earned on Total Assets 2003 2002 Net income RM 91,000 RM 76,500 Plus interest expense 6,000 12,000 Total 97,000 88,500 Total assets: Beginning of year 1,230,500 1,187,500 End of year 1,139,500 1,230,500 Total 2,370,000 2,418,000 Average 1,185,000 1,209,000 Rate earned on total assets 8.2% 7.3% Use: To assess the profitability of the assets.

  47. Profitability Measures — The Common Stockholder Rate Earned on Stockholders’ Equity 2003 2002 Net income RM 91,000 RM 76,500 Stockholders’ equity: Beginning of year 787,500 750,000 End of year 829,500 787,500 Total 1,617,000 1,537,500 Average 808,500 768,750

  48. Profitability Measures — The Common Stockholder Rate Earned on Stockholders’ Equity 2003 2002 Net income RM 91,000 RM 76,500 Stockholders’ equity: Beginning of year 787,500 750,000 End of year 829,500 787,500 Total 1,617,000 1,537,500 Average 808,500 768,750 Rate earned on equity 11.3% 10.0% Use: To assess the profitability of the investment by stockholders.

  49. Profitability Measures — The Common Stockholder Rate Earned on Common Stockholders’ Equity 2003 2002 Net income RM 91,000 RM 76,500 Less preferred dividends 9,000 9,000 Remainder—common stock 82,000 67,500 Common stockholders’ equity: Beginning of year 637,500 600,000 End of year 679,500 637,500 Total 1,317,000 1,237,500 Average 658,500 618,750

  50. Profitability Measures — The Common Stockholder Rate Earned on Common Stockholders’ Equity 2003 2002 Net income RM 91,000 RM 76,500 Less preferred dividends 9,000 9,000 Remainder—common stock 82,000 67,500 Common stockholders’ equity: Beginning of year 637,500 600,000 End of year 679,500 637,500 Total 1,317,000 1,237,500 Average 658,500 618,750 Rate earned on common equity 12.5% 10.9% Use: To assess the profitability of the investment by common stockholders.

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